On October 3, 2016, the Department of Finance released draft legislation that proposes to amend the principal residence exemption. Most of the amendments relate to non-residents owning or acquiring homes in Canada, and to trusts claiming the exemption.
The amendments come on the heels of various media reports that indicated that some non-residents were avoiding paying capital gains tax on Canadian homes in an inappropriate manner. There was speculation that this non-resident activity partially fueled the heated real estate market in some areas such as Vancouver.
(Readers may also be aware of the 15% purchase tax recently introduced for certain non-residents purchasing homes in Metro Vancouver, which is a separate tax issue from that described here.)
The “one-plus” rule
Under the principal residence exemption, the tax-exempt portion of the gain on the sale of a home is determined by multiplying the gain by the following fraction:
1 + B / C
where
B = the number of years the home is your principal residence and you are resident in Canada; and
C = number of years of ownership
Therefore, if you sell a home that was your principal residence for all years of ownership or all years but one, the entire gain is exempt. Since you can designate only one home as your principal residence for any one year, the “one-plus” rule is required if you sell a home and acquire another home in the same year. That is, only one of those homes can be your principal residence for that year, so the one-plus ensures that exemption is not lost on the other home.
The Department of Finance indicated that the oneplus rule was not intended to apply to non-residents. As a result, for dispositions occurring after October 2, 2016, the one-plus rule will apply only if the person is resident in Canada in the year in which the person acquires the property.
Trusts owing property
A Canadian resident personal trust that owns a property can qualify for the principal residence exemption when it sells the property. Generally speaking, under the current rules, a home owned by the trust can qualify as a principal residence for a particular year if a beneficiary of the trust, or a spouse or child of that beneficiary, ordinarily inhabited the home during the year. Although the trust must be resident in Canada, the beneficiary, spouse or child is not required to be resident in Canada.
Under the draft legislation, the type of trust that can qualify for the principal residence exemption will be restricted. In general terms, only the following types of trusts will be able to designate a home as a principal residence:
- Certain spousal or common-law partner trusts, joint spousal or common-law partner trusts, and alter ego trusts. These trusts provide that the relevant beneficiary must be entitled to all of the income of the trust and that no one else may use the capital of the trust during their lifetime;
- A qualified disability trust. This type of trust must have a beneficiary who is eligible for the disability credit, among other conditions; and
- A trust where the beneficiary is under the age of 18, whose parents are both deceased, and one of the parents was a settlor of the trust. (This is sometimes called an “orphan trust”.)
In each case, the relevant beneficiary must be resident in Canada in the year in which the trust designates the home as its principal residence. (There are more specific requirements that must be met.)
The new trust rules apply for taxation years beginning after 2016.
A transitional rule applies if a home owned by a trust qualified for the principal-residence exemption before 2017 under the current rules but does not qualify for exemption under the new rules. Basically, on a later sale of the property, the gain is separated into two components – one reflecting the gain accrued to the end of 2016 (which may be exempt under the current rules), and the second portion reflecting the gain that accrued after 2016.